Cyprus: Bailout deposit tax plan rattles markets

London: Stocks around the world and the euro fell sharply Monday as investors fretted over a plan to tax depositors in Cypriot banks as a way to partly fund a bailout of the Mediterranean island nation. Although Cyprus accounts for only around 0.2 per cent of the economic output of the 17 European Union countries that use the common euro, the tax on depositors was a significant policy shift that has stoked fears of bank runs in other troubled European economies.

Cyprus residents already emptied virtually all ATMs on the island in a weekend bank run. "If European policymakers were looking for a way to undermine the public trust that underpins the foundation of any banking system they could not have done a better job," said Michael Hewson, senior market analyst at CMC Markets.

The bailout of Cyprus foresees a 6.75 percent levy on deposits below (EURO)100,000 ($130,860), rising to 9.9 per cent on those above.

Since the European debt crisis began in late 2009, savers have been spared. But the bailout of Cyprus, agreed to early Saturday, foresees a 6.75 percent levy on deposits below (EURO)100,000 ($130,860), rising to 9.9 per cent on those above.

The Cypriot Parliament has to back the proposal for it to pass, and lawmakers have called it an unfair blow to small savers, since deposits around the eurozone have been guaranteed up to the (EURO)100,000 level. The vote was postponed for a second time as lawmakers discuss possible changes to the tax rates, with the parliament speaker saying it will now take place Tuesday.

One new proposal would make the tax more graduated: placing a one-time 3 per cent levy on deposits below (EURO)100,000, rising to 15 per cent for those above (EURO)500,000. "The bottom line is that it's very finely balanced and the success of the vote will depend on what tax breakdown goes before Parliament," said Adam Cole, an analyst at RBC Capital Markets. The prospect of further uncertainty weighed on markets.

In Europe, the FTSE 100 index of leading British shares was down 1 per cent at 6,428 while Germany's DAX fell 1.5 per cent to 7,958. The CAC-40 in France was 1.5 per cent lower at 7,955. Cyprus' stock exchange was closed for a bank holiday.

The euro was taking a pounding too, down 0.8 per cent at $1.2950. If it backs the levy, then Cyprus would be eligible for a (EURO)10 billion ($13 billion) financial rescue from its partners in the eurozone and the International Monetary Fund.

It's the first time that deposits have been tapped to fund an EU nation's bank bailout. German finance minister Wolfgang Schaeuble said a "no" vote by Cypriot lawmakers would have huge repercussions in the country.

"Then the Cypriot banks will no longer be solvent, and Cyprus will be in a very difficult situation," said Schaeuble, who insisted that every country involved in Europe's debt crisis is different. In the case of Cyprus, he said bank owners and investors had to participate in the rescue. "It can't be done any other way if we want to avoid insolvency," he said.

Cyprus' banking sector is about eight times the size of the economy and has been accused of being a hub for money-laundering, particularly from Russia. That's why many European officials wanted to have the banks' depositors involved in the cost of the bailout.

In Asia, Japan's Nikkei 225 index slid 2.7 per cent to 12,220.63, while Hong Kong's Hang Seng dropped 2 per cent to 22,082.83. Wall Street was headed for a retreat at the open too, with Dow futures down 0.6 percent and the broader S&P 500 futures 1 per cent lower.Oil prices were also under pressure, with the benchmark New York rate $1.20 lower at $92.25 a barrel.